Commodity prices as a tool for monetary management

With the help of a theoretical model---which is similar to Dornbusch's (1976) "overshooting" model with the inclusion of commodity prices---this dissertation's first point examines the relationship between a commodity price index and final policy variables. The purpose is to evaluate under which circumstances commodity prices---treated as an asset variable which reacts immediately to shocks unlike final prices, which tend to be sticky---provide usable information to the policy makers in predicting final policy variables. With respect to past literature, the model is stochastic and is solved in discrete time for every single shock. In the second part, the dissertation reexamines the empirical evidence on commodity prices as a leading indicator of final prices. Vector Error Correction estimates tend generally to support the importance of commodity prices as an information variable. The forecasting ability of this model is, however, rather poor; in addition, in most cases, the hypothesis could not be rejected that commodity prices do not "Granger cause" consumer prices. Regression analysis conducted on the same data yields more promising results, but only when explanatory and dependent variables are in first differences computed over 12 months, rather than over one month. In most cases, commodity prices (in levels and first differences) do have significant additional informative power in explaining and predicting consumer prices. Chow tests also suggest that the hypothesis of no structural breaks over the sample period (1975--1997) cannot be rejected at the confidence level of 5 per cent. In addition, there is some evidence that the signal extraction capacity of commodity prices has improved somewhat over the period 1994--97. In the latter part of the dissertation, it is shown that under certain circumstances the performance of a monetary rule a la McCallum---measured in terms of its capacity of reducing GDP variability---can be improved by adding commodity prices in the money creation rule.